Sunday, July 24, 2011

Will Higher Taxes Cost Jobs?

The debate about taxes in Washington is always the same: raising taxes will cost jobs. But what does history say about the subject? Will higher taxes cost jobs? Is there empirical evidence to support the claim?

Before we dig in too far I must point out I am not supporting one political party over the other, nor am I advocating for higher taxes. I merely point out historical facts on how tax increases affect job growth. No nasty emails, please. Respectful comments can be added below.

Income taxes in the United States began with the Civil War and were declared unconstitutional shortly after the war. World War I brought heavy financial demands on the Treasury, so an amendment was added to the Constitution allowing income taxes as we know them today. Income taxes started in 1913 and have continued unabated to today.

The first real opportunity to reduce income taxes significantly was after WWI. Major tax cuts to the top marginal tax rates in the mid 1920's lead to rapid growth in the economy. In a few years the over-heated, over-producing nation suffered a hangover called The Great Depression. The lesson learned is that lower top marginal tax rates provide a short-term boost to the economy followed by significant economic pain caused by the encouraged ramp-up in production. The lower rates encouraged current demand and sucked up future demand until a long recession was needed to work through the excesses.

Closer to home, President Kennedy reduced the top tax bracket from 90% to 70%. The 1960's were mostly good economic times. The economic issues of the 1970's were more related to demographics, expansion of the money supply during the Vietnam War, and oil shocks. Lowering marginal tax brackets that are very high seem to work long and short term.

President Reagan lowered top marginal tax brackets, too. Heavy emphasis was placed on encouraging supply by allowing fast expensing of assets for businesses. The economy boomed as employment increased and inflation dropped. The federal government ran large budget deficits during the entire period. If Social Security had the lower surpluses of today, President Reagan's deficit spending would have exceeded the rate of today's as a percent of GDP. The stock market crashed in 1987 by 22% in one day, the largest percentage drop on record. The economy only slowed without a recession and accelerated into the end of the decade before giving way to a real recession.

Like today, the 1990's saw a Democratic president and a Republican Congress from President Clinton's first midterm elections. Deficit spending that was acceptable to the Republicans under Reagan and Bush were untenable under Clinton. A tax increase coupled with spending cuts set the federal government up for the largest budget surpluses ever. But higher taxes did not kill the economy. Rather, the economy boomed with job growth, corporate profits, and the stock market walking hand in hand. Tax increases did not kill jobs in the 1990's because the top marginal tax rate was increased to 39.6%, a historically low top marginal tax rate.

Once Clinton left office, the newest Bush presidency set out to lower taxes by a massive amount. Deficit spending was back in place. More tax cuts over the first six years of George W. Bush created only a modest number of new jobs while expanding debt, public and private. By the end of the first decade of the Twenty-First Century the economy was in shambles, government receipts declining, job losses exceeding those created over the previous six years, and  nothing seemed to shake the sluggishness that set in.

Lower taxes did not help create jobs in the 2000's; slightly higher taxes gave us a job creating juggernaut in the 1990's. The tax code today has so many moving parts no one person understand the entire beast. Deductions and credits exist for every possible activity. Raising taxes by reducing deductions and credits should reduce the cost of complying with the tax code for individuals and businesses.

So the question remains: If we raise taxes will it cost jobs? It seems to me that a modest tax increase or a reduction in certain tax credits could actually encourage job growth. Any real effort to reduce Washington's red ink will require spending cuts and revenue increases.

Simplification of the tax code would provide real encouragement for businesses to hire. Businesses and individuals spend too much unproductive time gaming the tax system. A simpler tax code with fewer deductions and credits would allow certain tax rates to decline, especially for the middle class.

Remember, raising taxes are the thing to do as long as it is not my taxes being raised.

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